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Wall Street Breakfast: What Moved Markets

The S&P 500 (SP500) posted its worst weekly performance since mid-June, slumping 4.78% for the five-day session. The losses came on the back of a solid 3.65% gain last week. The selling pressure started on Tuesday after a hotter-than-anticipated consumer price inflation report, with the headline print for August rising 8.3% from a year ago. The sell-off continued after FedEx (FDX) pulled its full-year guidance and warned it will implement cost-cutting initiatives to contend with soft global shipment volumes due to what it sees as a significantly worsening global economy. On tap for next week, the Federal Reserve’s policy-making committee meets to set interest rate policy and Nvidia (NVDA) holds a key conference. See a preview of other key events in Seeking Alpha’s Catalyst Watch.

The Merge

The crypto community celebrated a big milestone for the Ethereum blockchain, which transitioned from the proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) model. The move aims to reduce the power needed to secure Ethereum by around 99.95%, easing the concerns of those worried about the environmental impacts of crypto (Ethereum currently emits as much carbon as Singapore and its total energy consumption is similar to the Netherlands). ETH (ETH-USD) issuance will also decrease (a.k.a. Triple Halving), while industry players will further decentralize the network by securing Ethereum at home, taking some control away from the institutions and sophisticated miners.

Backdrop: Ethereum researchers and developers decided to ease the transition into two steps, after the Beacon Chain successfully executed in December 2020. The update formed a separate parallel PoS chain – that could be tested in production without having a direct impact on the existing PoW network. It also grew the amount of staked ETH, so that it would be large enough to secure the network before the “Merge.” The second step happened this week, as the consensus layer of the Beacon chain was combined with the Ethereum PoW chain, and from the look of it, the transition was a success.

“If you’re a big company and you’re planning on investing millions of dollars in Web3 opportunities, whatever those might be, you want to know that the technology you’re building on is going to be consistent over time,” said Alex Tapscott of Ninepoint Partners. “Ethereum is clearly the leader of smart contracting platforms through a community-driven effort. And if all of a sudden there’s a deluge of big companies [that] are building on this new platform, you might think that seems like a pretty good investment opportunity.”

Explainer: In the PoW model, the Ethereum network is secured by miners, who have to buy and run mining hardware. The miners consume a lot of electricity in exchange for block issuance and a portion of the transaction fees. In the PoS model, the network is secured by validators who have to stake their own stash of ETH to validate the network, which is much cheaper and makes Ethereum more energy efficient (think laptops and desktops instead of powerful computer GPUs). It also makes Ethereum more secure, and lays some of the groundwork for enabling scalability and sharding down the line (which are extra chains used to circulate the network’s transactional load). (68 comments)

On recession’s doorstep

While FedEx (FDX) piled on the pain after sounding the alarm on macro weakness, markets tanked earlier in the week, and even recorded their worst day since the steep pandemic-driven volatility seen in 2020. The Dow (DJI) plunged nearly 1,300 points on Tuesday, leaving the index down 14% in 2022, while the benchmark S&P 500 (SP500) and tech-heavy Nasdaq (COMP.IND) tanked 4.3% and 5.2%, respectively, leaving them off 17% and 26% YTD. The broad selloff accelerated into the afternoon, in a force some attributed to outsized options activity, pulling every asset class deep into negative territory from stocks and oil to crypto and gold.

What happened? There were hopes that inflation would come in weaker than expected, meaning the Fed could (eventually) ease up on its quantitative tightening cycle, but by the way things look now, it may double down on its aggressiveness. The CPI print rose 8.3% Y/Y in August vs. the 8.1% consensus forecast, while core CPI – which strips out volatile food and energy prices – rose more than expected to 6.3%, from 5.9% in July. That’s despite gas prices that have come down tremendously over the past 13 weeks, suggesting that price pressures are seeping into more parts of the economy, like housing, college tuition and medical services.

The inflation report is one of the last the Fed will see before its September meeting next week, but it did enough damage to already worrisome policy expectations. According to the CME’s FedWatch Tool, there is now a 1 in 3 chance the FOMC will raise rates by a monster full percentage point, while the probability of a half percentage point fell to zero (meaning 75 bps is a given). If that’s the case, a full-fledged recession could be around the corner, with rapidly rising borrowing costs pushing any prospects for a “soft landing” off the table.

Response from the White House: “Today’s data show more progress in bringing global inflation down in the U.S. economy,” President Biden wrote in a statement. “Overall, prices have been essentially flat in our country these last two months. Gas prices are down an average of $1.30 a gallon since the beginning of the summer. This month, we saw some price increases slow from the month before at the grocery store. And real wages went up again for a second month in a row, giving hard-working families a little breathing room. It will take more time and resolve to bring inflation down, which is why we passed the Inflation Reduction Act to lower the cost of healthcare, prescription drugs and energy.” (146 comments)

‘Working on the Railroad’

Railway workers and companies finally came to a tentative labor agreement that would avert a strike, which was set to go into motion shortly after midnight on Friday. The Association of American Railroads said the deal would give rail employees a 24% wage increase during the five-year period from 2020 through 2024, as well as an immediate payout that averages around $11,000. While the contract covers around 60,000 workers, it still needs to be ratified by the holdout unions, and a sick-leave policy needs to be ironed out.

Quote: “The tentative agreement reached tonight is an important win for our economy and the American people,” Biden declared. “It is a win for tens of thousands of rail workers who worked tirelessly through the pandemic to ensure that America’s families and communities got deliveries of what have kept us going during these difficult years.”

The last-minute deal averted a strike that could have halted shipments of key goods, and disrupted the flow of commodities across the country. About 40% of long-haul trade is transported by rail, and a strike could have idled more than 7,000 trains, while costing the U.S. economy an estimated $2B per day. If things went sour, Congress had been readying a measure to impose contractual terms or send the dispute to forced arbitration. Emergency powers could have also been used by the White House for the delivery of critical materials.

Related: Canadian National Railway (CNI), CSX Corporation (CSX), Union Pacific (UNP) and Norfolk Southern (NSC). (100 comments)

Overpriced?

Traders were not a fan of Adobe’s (ADBE) new acquisition. The stock plunged over 16% on Thursday to $309, after Adobe – the owner of platforms like Photoshop, Illustrator, Acrobat and XD – announced the purchase of a design software firm known as Figma. The $20B transaction will be financed by an equal mix of cash and stock, with Figma CEO Dylan Field and company employees receiving 6M additional Adobe restricted shares that will vest over four years.

Bigger picture: Figma specializes in what it calls a “web-first collaborative design platform” that allows employees to use digital tools together on various types of projects. It’s a relatively unknown company, but its cloud-based collaboration tools have gained a faithful following among developers and product managers. Figma was only valued at $10B last year, and had been expected to see annual recurring revenue of $400M for 2022, which is only 2% of its sale price.

“While we think the acquisition makes strategic sense, let’s be honest. It feels like Adobe was losing some momentum to Figma and it was better to buy them out and combine forces,” said Evercore analyst Kirk Materne. “We think the company overpaid for Figma,” added Oppenheimer analyst Brian Schwartz, noting that the high price tag “indicates it was a defensive move, and the deal adds another layer of execution risk over the next few quarters.”

Bottom line: Adobe expects Figma to add to earnings by the third year after the deal’s completion, suggesting that company profits may see a negative impact from the deal for the next two years (at least). However, Figma does have gross profit margins of about 90% and operating cash flow is positive. Adobe also reported earnings yesterday that beat estimates, though guidance was mixed for the current quarter. (131 comments)

Regional trade shift

China’s warming ties to Russia were on full display this week at a meeting of the Shanghai Cooperation Organization ((SCO)) in Uzbekistan. The relationship between the countries has been growing over the past decade, as the two nations seek to counter the power and economic strength of the U.S. and its allies. In terms of size, the SCO is one of the world’s largest regional organizations, covering nearly 60% of the area of Eurasia, 40% of the world population, and more than 30% of global GDP.

Snapshot: “In the face of historical changes in the world and times, as major countries, China is willing to work together with Russia to play a leading role and to inject stability into the turbulent world,” President Xi Jinping declared at the start of the two-day conference. Bilateral trade between the nations, which topped $140B last year, grew by nearly a third in the first seven months of 2022, with commodities like heavily-discounted Russia oil making up a significant amount of the cross-border flows. Natural gas being transported via the Power of Siberia pipeline also hit records this summer, and China even announced that it would start paying for gas in rubles and yuan as the countries shun the U.S. dollar’s reserve currency status.

Meanwhile, Vladimir Putin praised China’s “balanced position” on the war in Ukraine, with many Chinese companies – from semiconductors to automakers – taking advantage of the exodus of Western brands from Russia. “We understand your questions and concerns in this regard,” Putin continued, adding that details of the war would be explained during meetings at the summit. In turn, Xi expressed appreciation for “Russia’s adherence to the one-China principle and stressed that Taiwan is a part of China,” especially after House Speaker Nancy Pelosi’s visit to Taipei in August.

Go deeper: Putin last met with Xi during a visit to Beijing for the Winter Olympics in February. At that gathering, the two authoritarian leaders framed their “no-limits” partnership and shared their opposition to the “further enlargement of NATO.” There’s also some new interesting dynamics at play, as India – which is a member of the Quadrilateral Security Dialogue and the Shanghai Cooperation Organization – has been scooping up cheaper Russian oil and much-needed weapons, while Iran just signed a memorandum to become a permanent member of the SCO. (5 comments)

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